Option pricing under fast-varying long-memory stochastic volatility
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Abstract: Recent empirical studies suggest that the volatility of an underlying price process may have correlations that decay slowly under certain market conditions. In this paper, the volatility is modeled as a stationary process with long-range correlation properties in order to capture such a situation, and we consider European option pricing. This means that the volatility process is neither a Markov process nor a martingale. However, by exploiting the fact that the price process is still a semimartingale and accordingly using the martingale method, we can obtain an analytical expression for the option price in the regime where the volatility process is fast mean-reverting. The volatility process is modeled as a smooth and bounded function of a fractional Ornstein-Uhlenbeck process. We give the expression for the implied volatility, which has a fractional term structure.
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Cited in
(17)- Correction to Black-Scholes formula due to fractional stochastic volatility
- Option pricing under model involving slow growth volatility
- Stochastic volatility and option pricing with long-memory in discrete and continuous time
- Forecasting with fractional Brownian motion: a financial perspective
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- Optimal hedging under fast-varying stochastic volatility
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